Flexible Prices and Leverage
53 Pages Posted: 24 Nov 2015 Last revised: 4 Feb 2017
Date Written: May 2016
The frequency with which firms adjust output prices is an important determinant of persistent differences in capital structure across firms. The most flexible-price firms have a 19% higher long-term financial leverage ratio than the most sticky-price firms, controlling for known determinants of capital structure. We rationalize this novel fact in a costly-state-verification model, in which sticky-price firms are more exposed to shocks, and face tighter financial constraints. In the model, a better monitoring ability reduces asymmetric information and narrows the leverage gap between inflexible- and flexible-price firms. Consistently, sticky-price firms increased leverage more than flexible-price firms following the staggered implementation of the Interstate Banking and Branching Efficiency Act across states and over time, which we use in a triple-differences identification strategy. Firms' frequency of price adjustment did not change around the deregulation.
Keywords: Capital Structure, Nominal Rigidities, Bank Deregulation, Industrial Organization and Finance, Price Setting, Bankruptcy
JEL Classification: E12, E44, G28, G32, G33
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